Best of Five Years (4): stock markets in developing countries (ll): basic questions

I’ve been writing Practical Stock Investing for something over five years now. I decided to go back through my archives so look at the most looked-at (and possibly read) posts over that time. I’m going to re-post ten over the next two weeks. This will give you a chance to see some of my earlier work that you may have missed. And I’ll have time for home repairs I’ve been putting off. I may just see a couple of baseball games and watch the basketball playoffs, though.

Here’s #4

Anyone who wants to actively select individual country funds or individual stocks in the markets of less developed nations has to consider a number of basic issues, the answers to which investors in developed markets take for granted. These include:

political stability, or the lay of the land. In most developed countries, politics makes for interesting discussion, but ultimately is not a crucial element in investment success.

Russia, in contrast, jumps out to me as a country where reading the political runes is more important than analyzing the assets or profit growth potential of any particular company and where the government’s attitude to foreign investors can change overnight. But there are lots of other examples, as well, like:

–the Hong Kong market was negatively affected for years in the early Eighties by the Chinese decision not to renew the British lease to the territory (after a while, however, local investors worked out that being Hong Kong Chinese with family connections on the mainland was like holding a winning MegaMillions lottery ticket, and the market began its ongoing long journey upward).

–during the late Nineties Asian currency crisis, Malaysia declared, in a burst of anti-Semetic rhetoric, that foreign portfolio investors were no longer allowed to sell stocks and remove the proceeds from the country. Foreigners were trapped for years.

–in 1994, the PRI in Mexico, in a desperate bid to remain in power, launched a massive government spending program funded by short-term notes, many of them denominated in dollars. The result was a massive currency and stock market collapse.

ease of entry and (more importantly) exit. A country–there must be some–may be entirely closed to foreign investment, or closed at least to foreign portfolio investment. We don’t have to worry about these. In addition, though:

–countries like China, India or Taiwan are only accessible directly to foreigners who establish themselves as Qualified Foreign Institutional Investors (QFIIs). Typically, this means showing you are a professional investor with, say, US$100 million in client assets under management and a certain number of years of experience. You commit yourself to fund an investment account in the country with, say, US$10 million, for a specified length of time and subject to substantial restrictions on your ability to withdraw the money.

–if you can’t/don’t want to qualify as a QFII, an institutional investor can usually arrange with a broker to buy an OTC derivative that creates the exposure it wants. Otherwise, you’re reduced to ADRs (American Depository Receipts) or GDRs (Global Depository Receipts, basically the same as ADRs but traded in markets like London or Hong Kong).

–costs can be a problem for an individual investor, especially in more esoteric markets or with smaller-cap stocks. In the US, and I presume elsewhere, foreign brokers will be reluctant for liability reasons to open an account for an individual. Traditional “full-service” brokers charge an arm and a leg for everything–and possibly more body parts to trade foreign stocks. Some discount brokers still charge on a cents-per-share basis, which is great for Swiss or small Japanese stocks but horrible for Hong Kong or Singapore. But e-Trade and Fidelity both have online international trading services where prices are very reasonable. (2014 note: nowadays, Charles Schwab, too.)

attitude toward foreigners. Who jumps up and down with joy when rich strangers swoop in to buy up (read: steal) a nation’s crown jewels at bargain basement prices? That’s the short answer.

Every country in the world–well, every one I’ve tried to invest in–, including hte US has restrictions on ownership of vital industries by foreigners. These are usually media and transport, but other industries may also be included. That’s taken for granted. The real question is whether there are other formal or informal constraints on foreigners.

Will a company meet with foreigners, or provide them with the same financial information they give to local investors? Not always. Are foreigners restricted to an inferior class of stock? Sometimes. How are foreign activist shareholders treated? Is merger or acquisition of weak companies by foreigners allowed?

local investor interest. Are there local institutional investors? Do individuals participate in the stock market? If so, what do they consider to be desirable attributes for a stock? If there are no local buyers of last resort, which is usually the case, you’re subject to the ebb and flow of interest from foreigners. If you want fast earnings growth and locals want stable profits and a high dividend yield, you may be trying to play checkers when everyone else is playing parcheesi (also known as Sorry!). That’s not a way to win.

For many markets, there are also what I’d call “invisible” issues. They’re the subject of my next post on the developing countries series.